Financial Markets Assignment Essay Example for Free

Financial Markets Assignment EssayExplain how stakesingness rates decline fol milding major(ip) cater purchases of mortgage- prated securities. The supply implements quantifiable easing by buying financial assets of spaciouser maturity, e. g. , mortgage-backed securities, from commercial banks and new(prenominal) private institutions in order to inject a pre-determined quantity of funds into the thrift. This is a means of touch on the sparing and lowering longer-term bear on rates further out on the yield curve numerical easing increases the excess reserves of the banks, and raises the prices of the financial assets bought, which lowers their yield. Graphically, this peck be explained with the aid of Figure at a lower place. The supply of funds is shifted from point 1 to the right (MS1 to MS2) and, all else equal, the new equilibrium point (with aggregate coin gather up curve) is at point 2, where the interest rate is lower. i i1 i2 AD1 MS1 MS2 Quantity of Mon ey 2. What could be the implications of lower interest rates for households and businesses? By implanting the insurance policy of purchasing mortgage-backed securities, the FED has set its sight on increasing white plague and investment, which impart ultimately increase employment.As described in question one Bernankes policy decreased interest rates to new record lows, encouraging scooping for both businesses and households. The ability to borrow money at more attractive rates stimulates investment in durable consumer goods, such as automobiles, and in operational necessities such as buildings and capital equipment for businesses. Indeed, after the implementation of the policy mortgage applications increase significantly.Because of low interest rates households and businesses as investors could shift their preference a right smart from bonds and into ocelluss. According to frbsf. org, the increase in stock trading volume has the effect of raising the value of existing stock po rtfolios, which in turning stimulates consumer and spending across the earth due to the psychological effects of rapid capital appreciation. Lower interest rates can have negative effects on the value of the local currency compared to other currencies.As external investors dump their local-denominated investments in favor of more profitable currencies, exchange rates can shift to the detriment of the local currency. The weakening of the local currency serves to increase the attractiveness of local goods to foreign purchasers, which has the effect of boosting exports and international sales. All of the circumstanceors mentioned above have the combined effect of increasing productive output, or GDP, and increasing employment across a wide range of industries.As individuals, businesses and foreign investors are congest to spend more due to increased access to capital, in tall spiritser portfolio valuations and weaker currency values, businesses in nearly all(prenominal) sector experience an increase in sales, often requiring them to grow their operations and employ additional comminute. However, at that place are some negative implications from this policy. Without a strong commitment to control inflation everyplace the long run, the risk of high inflation is one potential implication of experiencing real interest rates below the miserlinesss natural interest rate.Low interest rates provide a sizeable incentive to spend rather than save. In the short term, this may not matter much, but over a longer period, low interest rates penalize savers and those who rely heavily on interest income. If short-term interest rates are low relatively to long-term rates, households and firms may overinvest in long-term assets, such as Treasury securities. If interest rates rise unexpectedly, the value of those assets will fall (bond prices and yields go bad in opposite directions), exposing investors to substantial losses.Finally, low short-term interest rates red uce the profitability of money market funds, which are key providers of short-term credit for many (large) firms, e. g. the commercial paper market. 3. Explain the Feds policy dilemma and try to rationalize why unemployment in the US is stubbornly high while inflation is low. Based on the theory of the Philips curve diagram we notice that there is an inverse relationship between inflation and unemployment. Stated simply the lower the unemployment in an economy the higher the rate of inflation.Philips Curve Inflation Unemployment The explanation of the inverse relationship between inflation and unemployment is found on two assumptions. The first has to do with the fact that as unemployment rises there is no room for workers and labor unions to demand an increase so a wage inflation that would increase the prices of the final products cannot occur. Secondly high unemployment is a reflection of the decline in economic output and indicates an economys slowdown. Therefore opposition a mong firms in recession will lead the prices at lower levels. moreover this is not the case before long in the US since we observe high unemployment and low inflation. The FED is concerned about the unemployment rate and in an effort to stimulate the economy and improve the labor market conditions it started implementing the quantitative easing policy. So the FED purchased MBS, helped banks to rebuilt their balance sheets, contributed into maintaining price stability, preserved interest rates near zero for more than three years, and prevented the economy from slipping into greater recession. Despite all these efforts the situation in the labor market did not improve. manifestly the fact that unemployment is still very high depicts the limitations of the fiscal policy. The low business confidence, policy uncertainty, and the governments reluctance to act are beyond the FEDs capacity. What is more the infinite use of the quantitative easing may produce undesirable effects in the lon g run such as stagflation. The lone(prenominal) optimal solution under these circumstances is the co ordination of the FEDs monetary policy with the governments fiscal policy plan that could boost the societys confidence. . Do you think that another round of quantitative easing (QE) by the Fed would help stimulate the US economy? Please explain. The FED declared that the use of QE will be aggressively continued until the economy is improved. The cash injections into the economy helped interest rates to remain at low levels. Consequently everyone wins from this decision in the short run homeowners can borrow at historical low levels of interest rate, corporations can in addition take advantage of this act and invest, consumption increased and also the banks increased their profits and the stocks record a growth. So as long as the QE is active in the short run everyone is a winner. But in the long run things become vague. First of all historical evidence shows that despite the fact that interest rates may be at levels near zero it remains uncertain whether this will be the incentive to boost the actual economy. Secondly the fact that consumers will have more money to spend but fewer goods to buy might lead to a hyper inflation.Furthermore by reiterate the use of QE is very possible to lead to a liquidity trap, unless the economy finds ways to stimulate production. proceed but not least the FEDs decision to inject cash into the economy by purchasing MBS is questionable Mortgage backed securities entail the risk of defaulting once again as they did in the real estate crisis and that would cost the the Statesns a lot more money repeating the history that started back in the September of 2001. To sum up the use of QE is indeed very effective but only in the short run.Short periods of economic recession can be avoided by stimulating the economy temporarily through cash injections but to maintain growth on the real economy we direct to improve labor market condit ions, productivity, innovation and bolster the economys confidence. So a crew of fiscal and monetary policy is the only way to prevent an economy from collapsing, and also is this is the only way to avoid a possible systemic risk that will negatively affect all the institutions and individuals. . How is a loose Fed monetary policy in the US affecting fundamentals (such as inflation, asset and commodity prices) in other countries? What does that imply about global monetary policy? Since the dollar is the fomite currency in the global economy almost every country is tied to its value and everyone is touch on by the monetary decisions of the FED. By the QE, the supply of dollars is increased and consequently the dollar depreciates against foreign currencies.This means that Americas exports will increase and on the contrary the imports will decrease. So countries trading with the US upkeep about the capital inflows and the possible inflation on commodities. On the other hand the FED support that there can be no further inflation since the global economy is in recession. yet countries experiencing huge capital inflows resulting in inflation can implement fiscal policy, such as deluxe taxes, in order to contain the effects of foreign capital inflows which push up local stock prices and the currency itself.Every country should focus on its own monetary policy adjusting it to the problems that may experience. For use the US chose to inject more money in the economy. The results of such a decision are low interest rates, more exports but always with the risk of inflation. On the other hand a country experiencing high inflation might limit the money supply, increasing the interest rates with the risk of experiencing a decline in exports.